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Saturday, November 21, 2009

The Coming Asset Bubble

The weak dollar and it's potential to create an asset bubble is even concerning the Federal Reserve.

US Federal Reserve officials are stepping up scrutiny of the biggest US banks to ensure the lenders can withstand a reversal of soaring global-asset prices, according to people with knowledge of the matter.

Supervisors are examining whether banks such as JPMorgan Chase & Co., Morgan Stanley and Goldman Sachs Group Inc. have enough capital for the risks they take, how much they know about the strength of their counterparties and whether risk managers have authority to influence bank practices and policies.

..

The policy is raising the ``systemic risk'' of new asset bubbles, Bill Gross, who runs the world's largest bond fund at Pacific Investment Management Co., said in a note posted on the Newport Beach, California-based company's Web site yesterday. Finance officials in Asia say a bubble fueled by the Fed's low rates has already arrived.

There's a few things of note here. First, I've recently noticed, and been pointing out, that equities have been moving in the opposite direction of the dollar. So, strength in equities has come at the expense of the dollar.

Second, having the Federal Reserve be concerned about this is rather ironic. If in fact a bubble is forming then Federal Reserve is the first, second, and frankly only culprit in creating it. The weak dollar can be attributed to 1) artificially low rates and 2) the expansion of the money supply. Both of those are caused entirely by the Federal Reserve.

Third, Nouriel Roubini and his dollar carry back asset bubble theory are NOT mentioned in the story. That's peculiar because the story described his theory to a T. Roubini believes that the weak dollar is causing investors to borrow dollars and invest them in foreign markets where returns are potentially much higher. What is being described here? That's exactly what's being described.

The Fed isn't about to raise rates or sell back some of the assets they've recently bought to increase the money supply. Instead, they want to monitor the capital of banks and make sure that domestic banks are aware of their "counter parties" strengths. In other words, the Federal Reserve will monitor more closely to make sure that banks aren't overextended and that they're dealing with banks of good repute in the third world.

That's all good and well, but the Federal Reserve pumped the system with trillions in new dollas and lowering rates to zero causing this concern. Now, they want to monitor banks to make sure don't take too much advantage of the situation. That's sort of like your crack dealer making sure you aren't sharing needles. The right thing to do is to take away the crack, the massive amount of dollars and the obscenely low rates, not to make sure the banks are operating properly in the environment they've created.